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California State Senate Committee on Insurance
Hiram Johnson State Building
455 Golden Gate Avenue, Room B-100
San Francisco, CA
October 13, 1999
Consumers Union, the non profit publisher of Consumer Reports magazine, appreciates this opportunity to address the California State Senate Committee on Insurance on issues relating to the California Earthquake Authority (CEA).
Consumers Union's Position on the CEA
Since 1994, Consumers Union has been opposed to relieving insurers of their responsibility to offer earthquake insurance along with homeowners insurance policies. We opposed the establishment of the CEA because we do not believe that it is in the best interest of consumers-or the state-to have the state in the business of writing earthquake insurance.
Consumers Union wishes Insurance Commissioner Quackenbush had not sponsored the creation of the CEA. Large insurers such as State Farm, Allstate and Farmers wanted to protect their homeowners market share and limit their earthquake risks. The insurers particularly like to sell highly profitable auto and life insurance to homeowners. But when it came to earthquake insurance, insurers persuaded the Governor and the Legislature to get them of the hook for earthquake insurance with the CEA, and give much of the risk to the consumer.
Instead of creating the CEA, Consumers Union believes that many private insurance companies should provide multi-peril property insurance that includes earthquake coverage. These companies sell many lines of insurance and spread their risks geographically over the whole country. Then, to protect against all catastrophes, such as hurricanes, earthquakes and winter storms, they buy reinsurance on the world market. These reinsurance companies insure insurance companies for excess catastrophic losses. Reinsurers spread their risks worldwide.
That is how the private insurance market should work. Instead, we have a California-only, earthquake insurance only, state-run company dominating the bulk of that risky market. No wonder the coverage is terrible, rates are high, and much of the risk is on the consumer. Though there may be other theories on why the CEA is terribly undersubscribed, we believe that this is the number one reason why only 25 percent of California's homeowners have purchased earthquake insurance.
Although we opposed the creation of the CEA, we continue to monitor its development to ensure that the promises made to consumers are honored and that the interests of insurance consumers receive the attention they deserve.
Potential Stumbling Blocks for the CEA
Consumers will continue to avoid the CEA policy because it puts much of the risk on the consumer. This means that fewer homeowners will buy into the risk pool making it more difficult to spread the risk once a major earthquake occurs. There are several factors why consumers will choose not to purchase a CEA policy:
1. Nature and Cost of a CEA Policy
The basic mini-policy does not offer the consumer much value for the premium dollars paid out to purchase a CEA policy. The consumer must satisfy a 15% deductible on covered losses (there are many exclusions) before he can begin to receive payment for claims against a CEA policy. If the consumer gets beyond the 15% deductible on dwelling losses, only then is the consumer eligible to claim against the contents and loss of use portions of the standard CEA policy. Even then, the most a consumer can be paid on contents loss is $5,000, and only $1,500 for loss of use.
Although the CEA is now offering supplemental coverage, these options remain very expensive on a percentage basis. For example, a homeowner with $208,900 of dwelling coverage wishing to expand beyond the mini-policy must pay 52.5% more to reduce the deductible to 10%, increase contents coverage to $25,000 and increase loss of use to $10,000. This homeowner's earthquake insurance costs with a CEA policy will go from $856 for the mini-policy coverage to $1,305 for a mini-policy plus some supplemental coverage.
If this homeowner completes the CEA's retrofit program he will be eligible for a 5%, or $62.25, discount on his CEA policy with the features I just described. This homeowner would then pay $1,242.75 for a CEA mini-policy plus some supplemental coverage.
Compare this premium to what is offered by Pacific Select which offers a non-CEA stand-alone earthquake insurance policy.(1) For $772, this same homeowner would be eligible for a Pacific Select earthquake insurance policy that offers all of the features and more of a CEA policy with some supplemental coverage(2) at a price that is 69% less. Even after completing the CEA retrofitting program and obtaining a 5% discount on a CEA policy, a homeowner would still pay approximately 61% less for this competing policy.
Like the CEA supplemental policy presented above, the Pacific Select policy used in this example offers $10,000 coverage for building code upgrades. Like the CEA supplemental policy, it contains a 10% deductible, but that deductible amount is to each coverage limit. In other words, unlike the CEA policy, the policyholder does not have to satisfy the deductible against the dwelling before making claims against the other insured coverages. Additionally, this policy offers $104,450 of coverage for contents ($79,450 more than the CEA policy), $25,000 for loss of use ($15,000 more than the CEA policy), $20,890 coverage for other structures (CEA policy does not offer any coverage of this type).
The Pacific Select earthquake insurance policy is not available to all homeowners in all areas. Dwellings on slopes greater than 26 degrees are not eligible. Dwellings built prior to 1955 must be seismically retrofitted and documentation is required. Condominium buildings built prior to 1960 are ineligible. Dwellings built on stilts, pilings or poles are ineligible. However, homeowners who are eligible can benefit from the extensive coverage this policy provides at an affordable price.
As homeowners become more aware of the limitations of the CEA policy and the relative high cost of the supplemental coverage, more will shop around for better coverage at a better price. Those who are well informed will choose the most cost-effective alternative. Where homeowners are eligible for better policies at lower costs, the CEA will not be the earthquake insurance policy of choice.
2. Surcharge Potential
If the CEA must pay claims of more than $4.2 billion, policyholders will receive a 20% surcharge on their premiums so the CEA can pay more. For example, a policyholder paying $856 for $208,900 of dwelling coverage will have to pay an additional $171.20 to bailout the CEA. If claims cost more than about $7 billion and the CEA runs out of money, the CEA will pay pro-rata claims. For example, if claims are $10 billion, policyholders will receive 70 cents on the dollar from the CEA. This turns the usual concept of insurance on its head. No other insurance company assesses policyholders to pay off claims.
The potential for a surcharge to existing policyholders is quite large. The January 1994 Northridge quake caused $12.5 billion in insured losses. Although the homeowners who were paid for those losses had policies with more generous terms than the CEA offers, a quake causing one-third of the amount of losses on all CEA policies could trigger a surcharge. This potential for this loss level also underscores a likelihood that policyholders would receive only a pro-rata share, or dimes on the dollar, for their loss claims.
New Supplemental Coverage Package
As of September 1, 1999, the CEA has offered policyholders the option to increase personal property (contents) and loss of use coverage and to lower the CEA policy deductible from 15% to 10%. Policyholders can elect to increase personal property coverage in increments of $25,000, with an automatic increase in loss of use coverage independent of lowering the deductible. Alternatively, consumers can choose increased coverage and lowered deductible together as a package. We believe that it is important for the CEA to offer consumers more choice, particularly for those homeowners who are not eligible for a lower priced/higher coverage policy offered by a non-CEA insurer. Ultimately, the CEA will have to make its prices for supplemental coverage competitive with what's available on the private market in order to draw consumers to CEA policies.
New Mitigation Program
Consumers Union has long advocated that consumers look to earthquake loss mitigation as a first line of defense against earthquake related damages and losses. We recognize, however, that while retrofitting can be helpful in preventing losses it is no guarantee against losses. Therefore, adequate insurance is still a key factor in protecting homeowners against earthquake losses. Notwithstanding our comments about the CEA and the value of CEA policies, we believe that the CEA is moving in the right direction by making efforts to assist some California homeowners with mitigation efforts through the State Assistance For Earthquake Retrofitting "SAFER" Program. Currently, homeowners in 8 Bay Area counties may be eligible to participate in the SAFER Program.
While it is still too early to assess the effectiveness of the program which began on September 30, 1999, the Program appears to implement many necessary components for success. Consumers can call a toll-free number where they speak to a "live" person. The consumer is asked a few simple questions to determine eligibility for the program. If the consumer is eligible, an information packet is sent to the consumer. The consumer completes and returns to the CEA a postcard check-off list and request for inspection. A consumer participating in the program is eligible to receive a free seismic assessment of the home, access to a pool of contractors deemed "qualified" by the CEA, and a choice of financing options to pay for any necessary retrofitting. Additionally, those completing the program will be eligible for a 5% discount on a CEA earthquake insurance policy.
Suggestions for Improvement
The CEA must be prepared to meet the consumer demand for this program or consumers will be discouraged from participating. In the "SAFER Program Update" included in the Program information packet, consumers are informed that "because of the large volume of requests . . . it may take several months for some inspections to be completed." This suggests that the CEA either did not anticipate the level of public demand or is incapable of handling the volume of requests in a shorter period of time. Consumers Union strongly recommends that the CEA make every effort to process the requests as soon as possible. This may require adding more staff to meet the public demand. Unfortunately, Californians know that earthquakes are unpredictable and can strike at any time. Mitigation can make the difference in protecting the public against major earthquake losses, including loss of life. While Consumers Union is not aware of the actual number of requests, the SAFER Program Update suggests that the public is ready willing and able to start retrofitting and the CEA must be prepared to meet the demand.
Consumers Union urges the CEA to expand the SAFER Program statewide. We are aware that the Earthquake Retrofit Grants and Loans Program has been expanded into 20 counties, but the SAFER program offering free inspections is limited to just 8 counties. As we know from past experience, earthquakes occur throughout California and are not confined to any one geographic area. Homeowners outside the 8 Bay Area counties eligible for the SAFER Program need the same amount of encouragement and access to services that the SAFER Program provides. We would like the CEA to report to the Senate Committee on Insurance about how and when it will provide SAFER services to all Californians.
Critical to the success of the SAFER Program however, is the CEA's ability to make the public aware of the existence of the Program. The CEA needs to employ every avenue to get the word out to the public. Conduits for outreach and education should include all CEA participating insurers, real estate agents and brokers, and title companies which are likely to encounter homeowners or prospective homeowners seeking information. Additionally, participating insurers should mail notices to all current CEA policyholders and to all homeowners insurance policyholders. Notices should be placed in county property tax bills in all participating counties.
Consumer Outreach Efforts of the CEA and Insurers
The major goal of any CEA outreach effort is to inform the public about the availability of earthquake insurance policies, CEA and otherwise, so that homeowners will insure their properties for damage caused by an earthquake. Therefore, one measure of the effectiveness of any outreach effort is to compare the number of households holding earthquake insurance policies prior to and after the creation of the CEA.
In April, 1999, the Associated Press reported that "major insurers had about 1.3 million earthquake policies in effect as of Dec. 2, 1996, when the California Earthquake Authority opened for business."(3) By contrast, "Those same companies, through the CEA, now have only about 940,000 policyholders."(4) This is a significant drop, 38% less, in the number of households covered by earthquake insurance. According to the CEA website(5) only 25 percent of all California households carry earthquake insurance. This means that the great majority of households, 75% of the total number, carry no earthquake insurance whatsoever.
Is insufficient outreach the problem? Perhaps. Most consumers will learn about the availability of CEA policies through their homeowners insurance provider. Homeowner's insurance providers who are also CEA participants naturally steer the homeowner to a CEA policy. Clearly, many homeowners are choosing to forego a CEA policy but they are not learning about the existence of other non-CEA policies from their insurance agents. The CEA participating insurers who are in direct contact with homeowners shopping for earthquake insurance do not provide this information as a matter of course. The CEA should require all participating insurers to inform their homeowners insurance policyholders about the existence of alternative earthquake insurance policies in order to realize the goal of more households insured against earthquake loss.
Many homeowners operate under the impression that their CEA participating homeowners insurer will pay out the claims on the CEA policies it brokers. They look to the reputation of the CEA participating insurer, rather than to the CEA itself, when deciding if it is a good risk to purchase a CEA policy. In this sense, the CEA and the participating CEA insurers need to do more to educate the public about choice and the ultimate responsibility for and likelihood of paying out claims on a CEA policy.
Some have suggested that the significant drop in the numbers of homes covered by earthquake insurance is because homeowners are less inclined to purchase earthquake insurance as more time passes between major earthquake events. Consumers Union does not have any evidence of this. We do know, however, that it is difficult to interest a homeowner in buying an earthquake insurance policy that will most likely not return value for the money paid out. As discussed earlier, the current CEA mini-policy does not offer much for what the consumer is charged. Other non-CEA insurers are finding ways to offer more earthquake coverage at lower costs and will attract more eligible homeowners to their policies as the public because more informed of their existence.
In summary, Consumers Union believes that the CEA has a long way to go before it begins to serve the earthquake insurance needs of Californians. We believe that the new mitigation program and the new supplemental coverage packages offer consumers more choices. Nonetheless, the CEA insurance policy is still not the best value for the money, particularly for those households that will be eligible for a lower cost policy with more coverage from a non-CEA insurer.
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Footnotes:
(1) Consumers Union does not endorse any individual earthquake insurance product or company. This information is provided for comparison purposes only.
(2) CEA policy with some supplemental coverage including a 10% deductible, $25,000 contents coverage, and $10,000 coverage for loss of use.
(3) John Howard, "Fewer opt to take quake insurance from state-run pool," Associated Press, April 28, 1999.
(4) Id.
(5) http://www.insurance.ca.gov/EXECUTIVE/CatSeries/Earthquake/Earthquake4.htm, September 27, 1999.
